The announcement on Wednesday that RCAP Holdings, led by real estate investor Nicholas Schorsch, is acquiring independent broker-dealer First Allied Securities from Lovell Minnick Partners has prompted experts to debate the role of private-equity in the broker-dealer industry—particularly the independent broker-dealer field.
To get an in-depth perspective on the subject, AdvisorOne spoke with Philip Palaveev (left), CEO of the Ensemble Practice, an advisory-practice consulting firm based in Seattle. He addressed the following questions:
Why does there seem to be so much interest by investors in broker-dealers like First Allied?
We are seeing the investment-advisory industry, including wealth management and financial management, mature, and as it does, it’s consolidating.
You also see mergers & acquisitions when an industry is successful. By and large, consolidation is a sign of success —and that means it attracts institutional capital, because the industry needs more money from private equity, public markets and other sources.
Broker-dealers have consolidated a lot, very heavily. First Allied was institutionally owned already, so it’s essentially going from one professional investor to another and not really changing character.
The news, though, was definitely surprising to see, but you don’t have to read a lot into it. Independent broker-dealers will continue to attract the interest of investors, because it’s a very successful business, and the growth potential attracts opportunistic capital.
So, current investor interest is related to the evolution of the industry?
It’s very, very true for any industry in transition or a young industry moving to a more mature stage. That’s because as young, entrepreneurial firms grow into larger, more sizeable competitors, institutional capital steps in as owners. Lots of capital is needed for larger firms [to operate successfully], and that can’t be supplied by individual entrepreneurs.
This is true for financial advisory firms, broker-dealers, wealth-management companies—everybody. We are seeing this trend, along with consolation and institutional ownership, as larger entities need more capital. How much can a family wealth office, investment advisory firm, or other play in the financial planning industry afford? These trends are true of every player, not the just the broker-dealer industry, including RIAs and the wirehouses.
Financial planning is a young but maturing industry, and that is why we see the institutional ownership increasing, including private equity—which is a subset of institutional capital.
The industry is seen as growing and highly lucrative. The interest of private equity is a signal that this is an industry of opportunity. That’s good news—nothing else.
Are we at a particular stage in the investment cycle or history?
In terms of IBDs and their evolution, they were very small, with 100 or so advisors, and then they grew in size, scale and scope to become more successful. The insurance firms — AIG, ING, etc. — were the first to notice them.
Now, we are seeing a much broader recognition of this business model in general versus 20 years ago, when Wall Street and its investors wouldn’t have heard much of IBDs. Today, LPL Financial (LPLA) has ads on television; Raymond James (RJF) and NFP (NFP), for instance, also are large, well-established names. This is a second wave of investment that shows a broader recognition of the business model. In addition, the United States is experiencing a rise in private-equity investment and participation in a variety of business, like manufacturing, hotels, etc. There’s really a much broader focus, and private-equity now caters to lots of investors who own many of the best-performing companies in the United States. This—of course—means that private-equity trends will affect the broker-dealer industry.
In a healthy market, you will see changes of ownership, especially in consolidating markets. And there are not many targets remaining in the IBD space that are sizable, other than say Cambridge and Commonwealth Financial.
Keep in mind, though, institutional ownership is a reality for this industry, and it has been that way for some time.
Check out 7 Predictions for the Advisory Industry: Philip Palaveev on AdvisorOne.